Where Credit’s Due Ep.13: The growing popularity of virtual cards, with Deserve and M1

The growth of digital banking has also welcomed the emergence of virtual cards. Virtual cards exist only in digital form, in a digital wallet. Say bye to plastic and hello to code. 

Some digital challenger banks allow customers to create virtual cards in a matter of seconds. To shop more securely online for example, one can create a virtual card and even destroy it after the purchase was made. 

This is a big reason why virtual cards are increasing in popularity – they offer more robust security measures, making it harder for hackers and fraudsters to skirt the system. 

There's also very compelling business use cases for virtual cards. Corporate expense management might be moving from tediously having to submit all that boring info about that client lunch to just tapping a virtual corporate card with a smartphone. 

Some have even called this a revolution in business expense management – no more boring time consuming software, now a company can issue however many corporate cards it wants and each card can have its own restrictions.

I'm talking about all of this today with my guests Kalpesh Kapadia, CEO at Deserve, a credit-card-as-a-service provider, and Brian Barnes, CEO at personal finance platform M1.

The credit card has essentially evolved from plastic to code, and Kalpesh I'd like to start with getting your overview of this transition. How do you see this evolutionary step? 

Kalpesh: As you rightly pointed out, money in general is moving from cash to plastic to code. It's a 50 year transformation of money, and we are in the middle of the transformation. Apple launched their credit card product in 2019. 30 years prior to that, the industry was organized in the analog era - mainframe, manual processing, batch processing, plastic, all that. The mobile app was kind of an afterthought that you could download. 

Apple flipped the paradigm. There are about 50 devices over the course of the 15 years that have been sucked into the iPhone. I think driver's licenses are going to be next, credit cards are already in digital wallets. So we believe that over the next 10 years, as more and more terminals start accepting Apple Pay, Google Pay, contactless payments, more and more cards are going to become part of your digital wallet, and you'll actually ditch your actual wallet. 

So there's two camps here. One camp is advertising heavily saying what's in your wallet, which are the Capital One's of the world, and Apple wants you to ditch your wallet. So we believe that, ultimately, the digital experience is superior in all respects, so the industry is going to move in that direction. And we want to be there.

Digital is slowly but surely becoming the default way in which we operate, and financial transactions are at the heart of that. Brian, what do you think? What's the role of a credit card in a digital economy?

Brian: I 100% agree with Kalpesh on everything that he said. In the most abstract form, the credit card, the more interesting part of the credit card is the credit portion that people need to pay for everything in cash. That's what retailers accept. That's what people expect as they get paid for various things. For an individual managing their finances, it's relatively expensive to keep all the liquidity on hand to manage that. And so the credit card came out and the line of credit came out where it says the bank says, We will give you free access to liquidity up to a certain limit. If it's free for 30 days, if you go beyond that, we're going to start charging you but it is an extremely powerful concept for an individual to manage their day to day spending. 

The card aspect of that is just how you access it. And I think if the least interesting part of it, there's no reason why it needs to be tied to a piece of plastic, there's no reason why it can't be accessible via a lot of things, whether that's your mobile device, a watch token on the internet and the like. I think by going digital, you just have a lot more forms that are more convenient, more secure, easier to access on you at all times, it's not an additional piece of things, the piece of plastic that you need to carry around. And so being able to abstract away the credit and the card portion from the credit card just makes it a lot more beneficial for the end user.

Going fully digital is making everything more accessible. It's reaching a wider audience. But with increasing scale also comes a rise in fraud. I think a lot of a big reason why virtual cards are increasing in popularity is because they do offer more robust security measures. And I want to ask both of you on this front, what are you observing? And why is this the case?

Kalpesh: Clearly, the device footprint, the ID associated with the device, in the card authentication, all these things taken together is providing more security, if you will, to each transaction because of the awareness as to where you're using the card. 

For instance, if someone gets my card number and starts using it in the Philippines, there is a flag that, hey, this person typically doesn't travel outside of this geolocation or this radius. How come this card was swiped somewhere halfway across the world, right? With phones and cards, you can marry those two together and have better awareness of the person's patterns, if you will, and manage security better in a seamless way in a frictionless way.

If you go to a gas station you have to enter your zip code every time. If I'm in Ohio, and have a rental car, I have to enter my Palo Alto zip code –  these are sort of very basic rules that people have on the code base or transaction pattern base or velocity base rules. Digital reduces friction, it can give rise to fraud, but you can also manage fraud better. 

The Apple Card is a perfect example or Deserve Card, where we don't have a number on your card. So for any reason I lose my card, people can't get access to my 16 digit account convert or CVV or expiry date. Right there, you have security, and then you can freeze the card from your app. How many times have people lost their wallet or had it stolen, and then you have to cancel all your credit cards? You can do all of these things in a digital world, much, much better than calling each car company and saying, Hey, cancel my card, or calling the credit bureau and putting a freeze on things?

Brian: I think the reasons for fraud are, unfortunately, relatively obvious. I really do think that the modern day bank robber, so to speak, is not someone who wears the cowboy hat and holds up a bank, but it's really someone who has a laptop in a remote location and is able to access things digitally. They're trying to get money through illicit means and profit from that. 

The big thing that a finance firm has to contend with is for every transaction, how likely is it that that person who owns the card, who has authority over it, is making that transaction. In the analog world that Kalpesh talked about, it's really only holding on to the physical piece of plastic and typing in something that you may know, something like a zip code of where you live in the digital world, you actually have a lot more information. You have a phone that may have a PIN code, or a face ID or a thumbprint authentication on it, you can have location services enabled, if every transaction that you do is digital, you have a very robust data set of the patterns that every single person goes through, you can match that on their individual patterns on holistic patterns. 

And so it is really, by moving everything to the digital world, you just get the powers of computers to analyze every single transaction and make a much more robust decision on who should own the card making this transaction. It's an arms race, so to speak. There's different fraudsters that are trying to beat that. But the fraudsters get a benefit through not having to be in person to commit the fraud, being able to do it in a remote location with an internet connection. The digital finance firm gets the ability to have a whole lot more data to base their anti-fraud decisions on and really make it robust, to decide to decline to remove and track all of these things.

Kalpesh: That's an excellent point, Brian, and I would even add, physical card security can be improved by marrying it to the device. We are all used to two factor authentication. Apple is now sort of talking about the vicinity – if your phone and your laptop are not in the same vicinity, it gives you an alert. You could do things like in a car and the phone are within 30 feet of each other. So if you forgot your phone, in your car and your target, it will still work as long as it's in the periphery of where you are. You could create some sort of rules which are two factor authentication and improve physical card security as well.

It's a really interesting thing that you said, Brian, regarding all the data points that can be gathered. And I wonder who owns the data in this case? Is it the credit card provider, the payments company, or is it the bank? Do we even know who has control over all these data points on the consumer?

Brian: It is a very good question, and truthfully, probably above my paygrade. I know that this is going to be debated. Ultimately, I actually think it's beneficial for both parties to have access and control over the data, that the individual is the one taking the action to make the data – there's helpfulness and transportability to be able to do with that data what you want. To help people improve their finances, having more data on the individual helps us do that. 

We are investing incredibly heavily in building systems and technology and processing, all of which take time, energy, money, and the sheer intellect of the engineers that do the work. We do need that data to provide the customer experience that, truthfully, the customer wants. The legality of it, I'll let our congress people debate that. I do think the finance firm has a big benefit of having a lot of data on the customer, I think it drives a better consumer experience. And I do think that there is a little bit of a tilt that if they have data is nefarious, and I just don't view that to be the case. We've come to work every day trying to help people improve their finances. And so that is our motivation and why we collect the data that we do.

Kalpesh: I would add that it's an opt in basis. So the consumer opts in to add the security features. It is data used in that context. Our terms of service have to be very clear as to why I need this data, and what benefits you're gonna get from this data. And we're not going to share it with anyone else. Apple is at the forefront of privacy. Now, I believe the CFPB is coming out with an open banking data policy, so there's a lot that is going to be decided or regulated over time. But ultimately, as Brian said, we are on the consumer's side. So you want to help them improve their finances, help them reduce their fraud, and go through the hassle. If you are explaining it properly, and you're messaging it properly, I believe consumers will opt into it.

Today it's all about personalized financial services, and you can only do that with massive amounts of data points. But yeah, on the consumer side, a lot of those data privacy aspects will be decided in the future. I'd like to talk about the corporate use cases of digital cards as well. There's been a lot of interest with virtual cards in business expenses management. What's the demand like from the corporate sector for these types of services? 

Kalpesh: I believe that on the corporate or small business side, as Brian earlier mentioned, the 30 day credit cards are important when you're managing cash flows of your businesses. Forget about the cash flow as a household. For business cash flow, providing that float to businesses is one thing that's powerful. 

The second thing is card controls for your employees or by department. If you are a marketing person, you can spend $500 a day on Facebook or Google search, marketing. You have controls as a CFO saying, 'Okay, this department needs this much budget to spend on this merchant for this service'. 

Also, transparency, expense management, budgeting, integration with accounting software. Once you make a card transaction with a digital entity, you can move data around in your stack, and you can integrate with other service services seamlessly. And I think that is why it is super important to make cards and transactions and payments digital. So that you have better controls, better transparency, better accountability, all of that. And I believe that is happening in corporate expense management, the likes of Ramp and Brex.

Brian: I think of credit cards almost as a pyramid of needs, for lack of a better term, and the base of the pyramid, it's truthfully, just the access to credit. We talked about that at the beginning of this interview, of people needing liquidity to manage their day to day life. And it's expensive to hold all of that on hand yourself.

The banks can come in and facilitate that. We've talked about security – it's not just good enough to have access to credit that anybody can access, you have to lock down the parameters and only have the person who is authorized to use it, use it. 

Moving up the pyramid is cashback, I think that's a huge aspect of the way the economics of the credit card work. There's truthfully, just a little bit of excess profit in it. And a lot of these companies compete, and they're rebaiting the excess profit back to the customers through cashback. It makes for a very efficient industry, and the customer benefits as a result of that. 

And then I think at the peak of the pyramid, it's all the analytics that Kalpesh talked about, of when it's digital, how can you use this information to make very personalized insights, recommendations and analytics for all these things. That's where I think a lot of the interesting stuff exists, and I really do think of it as foundational stuff. Some of that has been handled by traditional credit cards over time. As we digitize everything, the analytics just become super powerful and impactful in the ability to provide insights and recommendations on how people want to manage their money.

It's true, and this is really innovative for corporates that are used to spreadsheets or cumbersome software when expensing things. And also why I'm curious to hear your thoughts about credit-card-as-a-service; which is a very interesting example of embedded finance, really. Kalpesh, Deserve is a key player in this sector, can you give us a quick overview?

Kalpesh: We pioneered the term credit card as a service — we are the leader in this space. We believe that the next frontier in banking as a service is credit cards. A lot of companies can do sort of prepaid cards, debit cards as a service. I think that credit is complex, underwriting is super important when you're issuing debit cards. People are putting money with you, right? So, you have to do KYC. It's their money, they're spending it over time. That's one thing here, that is different, that credit card is underwriting because you are giving money away. And you need to know who you're giving money to whether they are credit worthy or not. There are many ways to determine credit worthiness, not just through credit scores. So that's one aspect of it. 

The other aspect of it is, interchange is higher. Most debit cards are very low interchange, at least the ones that are powered by large banks. So there are no rewards associated with it. So that's underwriting, rewards capability or catalog or policy, whatever you want to call it, disputes and chargeback is another key aspect of it. 

And then credit has many years of regulations that are different, there are about 13 regulations that apply to credit cards, and you need to be compliant in every way. Because this is one product where you reject customers, so you have to be very careful in being compliant from a fair lending standpoint. So that's another differentiation there. And then servicing when you're halfway across the world, and you need to call someone to understand why the fee was charged, or you lost your card or things of that sort. So a lot of nuances that make it super complex to manage, and we bring it under one roof with one contract and one API.